- Title: A Random Walk Down Wall Street
- Sub-title: The Time-Tested Strategy for Successful Investing
- Author: Burton G. Malkiel
- About the author: Burton Malkiel is an American economist and writer, most known for his classic finance book A Random Walk Down Wallstreet. He currently serves as Chief Investment Officer for Wealthfront and as a member of the Investment Advisory Board for Rebalance
- Pages: 480
- Published: 2020
- Link to book
Simply put, A Random Walk Down Wallstreet is a readable investment guide for individual investors. It doesn’t matter if you are a complete newbie or someone with a Master’s degree in finance. This fundamental book can serve you.
Although this is primarily a book about common stocks, author Burton Malkiel also covers everything from insurance to income taxes. You’ll learn about behavioral finance, financial history, a variety of asset classes, how to pros play the “game”, risk vs reward, and much more.
The phrase in the title “a random walk” refers to a random walk being one in which future steps or directions cannot be predicted on the basis of past history. When using this phrase in reference to the stock market, it means that short-run changes in stock prices are unpredictable. This is a major premise in the book.
The version we are reviewing today is the 12th edition, with the first edition having been released over 45 years ago! Burton says the message of this book hasn’t changed since the original edition: Investors would be far better off buying and holding an index fund than attempting to buy and sell individual securities or actively managed mutual funds.
Mr. Malkiel says this book will take you on a random walk down Wall Street, providing a guided tour of the complex world of finance and practical advice on investment opportunities and strategies.
I have read many books on finance, personal finance, and investing over the past 8-10 years. I believe A Random Walk Down Wallstreet should be one of the first books someone reads when they are learning the fundamentals of the arena of finance.
Even if you believe you are seasoned in financial literacy, if you haven’t read this book, you definitely should.
A Random Walk Down Wallstreet has been a bestseller for several decades for many reasons. If you are looking for an encompassing book on finance, this is the perfect read. The 12th edition of the book was released in 2020, so you’ll get to read about the most recent updates of the advances in investment theory and practice
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There are many takeaways from the book and I’ve divided them into 3 buckets:
- Facts, Analysis, and History
- Investment Principles and Guidance
1. A random walk is one in which future steps or directions cannot be predicted on the basis of past history. When the term is applied to the stock market, it means that short-run changes in stock prices are unpredictable.
2. I view investing as a method of purchasing assets to gain profit in the form of reasonably predictable income (dividends, interest, or rentals) and/or appreciation over the long term. A speculator buys stocks hoping for a short-term gain over the next days or weeks.
3. Traditionally, the pros in the investment community have used one of two approaches to asset valuation: the firm-foundation theory or the castle-in-the-air theory.
4. A bubble starts when any group of stocks, in this case those associated with the excitement of the Internet, begin to rise. The updraft encourages more people to buy the stocks, which causes more TV and print coverage, which causes even more people to buy, which creates big profits for early Internet stockholders.
5. Technical analysis is the method of predicting the appropriate time to buy or sell a stock used by those believing in the castle-in-the-air view of stock pricing. Fundamental analysis is the technique of applying the tenets of the firm-foundation theory to the selection of individual stocks.
6. The efficient-market hypothesis explains why the random walk is possible. It holds that the stock market is so good at adjusting to new information that no one can predict its future course in a superior manner.
7. A security whose returns are not likely to depart much, if at all, from its average (or expected) return is said to carry little or no risk. The “variance” is a measure of the dispersion of returns. The square root of the variance is known as the standard deviation.
8. Modern Portfolio Theory: The theory tells investors how to combine stocks in their portfolios to give them the least risk possible, consistent with the return they seek. As long as there is some lack of parallelism in the fortunes of the individual companies in the economy, diversification can reduce risk.
9. Behavioralists believe that many (perhaps even most) stock-market investors are far from fully rational. Behavioralists believe that market prices are highly imprecise. Moreover, people deviate in systematic ways from rationality, and the irrational trades of investors tend to be correlated.
10. Behavioral finance then takes that statement further by asserting that it is possible to quantify or classify such irrational behavior. Basically, there are four factors that create irrational market behavior: overconfidence, biased judgments, herd mentality, and loss aversion.
11. The traditional IRA offers “jam today” in the form of an immediate tax deduction (provided your income is low enough to make you eligible). The Roth IRA offers “jam tomorrow”—you don’t get an up-front tax deduction, but your withdrawals (including investment earnings) are completely tax-free.
12. Dollar-Cost Averaging can reduce the risks of investing in stocks and bonds. Periodic investments of equal dollar amounts in common stocks can reduce (but not avoid) the risks of equity investment by ensuring that the entire portfolio of stocks will not be purchased at temporarily inflated prices.
Facts, Analysis, and History
1. More than two-thirds of professional portfolio managers have been outperformed by unmanaged broad-based index funds.
2. Greed run amok has been an essential feature of every spectacular boom in history. In their frenzy, market participants ignore firm foundations of value for the dubious but thrilling assumption that they can make a killing by building castles in the air.
3. The consistent losers in the market, from my personal experience, are those who are unable to resist being swept up in some kind of tulip-bulb craze.
4. The bubble in single-family home prices that inflated during the early years of the new millennium was undoubtedly the biggest U.S. real estate bubble of all time. The combination of government policies and changed lending practices led to an enormous increase in the demand for houses.
5. Including markets for futures, options, and swaps, trillions of dollars of transactions take place each day.
6. In estimating the firm-foundation value of a stock, the fundamentalist’s most important job is to estimate the firm’s future stream of earnings and dividends. The worth of a share is taken to be the present or discounted value of all the cash flows the investor is expected to receive.
7. There are 3 potential flaws to fundamental analysis: First, the information and analysis may be incorrect. Second, the security analyst’s estimate of “value” may be faulty. Third, the stock price may not converge to its value estimate.
8. An investor who frequently carries a large cash position to avoid periods of market decline is very likely to be out of the market during some periods where it rallies smartly. The point is that market timers risk missing the infrequent large sprints that are the big contributors to performance.
9. At heart, the Wall Street pros are fundamentalists. The really important question is whether fundamental analysis is any good.
10. Unfortunately, the careful estimates of security analysts (based on industry studies, plant visits, etc.) do little better than those that would be obtained by simple extrapolation of past trends, which we have already seen are no help at all. Financial forecasting appears to be a science that makes astrology look respectable.
11. There are, I believe, five factors that help explain why security analysts have such difficulty in predicting the future. These are (1) the influence of random events, (2) the production of dubious reported earnings through “creative” accounting procedures, (3) errors made by the analysts themselves, (4) the loss of the best analysts to the sales desk or to portfolio management, and (5) the conflicts of interest facing securities analysts at firms with large investment banking operations.
12. Better still for my argument, the men and women at the funds are some of the best analysts and portfolio managers in the business. Again, the evidence from several studies is remarkably uniform. Investors have done no better with the average mutual fund than they could have done by purchasing and holding an unmanaged broad stock index.
13. Because stocks can be combined in portfolios to eliminate specific risk, only the undiversifiable or systematic risk will command a risk premium. As the systematic risk (beta) of an individual stock (or portfolio) increases, so does the return an investor can expect.
14. No single measure is likely to capture adequately the variety of systematic risk influences on individual stocks and portfolios. Nevertheless, we must be careful not to accept beta or any other measure as an easy way to assess risk and to predict future returns with any certainty.
15. Losses are considered far more undesirable than equivalent gains are desirable. Kahneman and Tversky concluded that losses were 2½ times as undesirable as equivalent gains were desirable. In other words, a dollar loss is 2½ times as painful as a dollar gain is pleasurable.
16. As long as the world’s population continues to grow, the demand for real estate will be among the most dependable inflation hedges. But the real estate market is less efficient than the stock market. Ownership of a house is a good way to force yourself to save, and a house provides enormous emotional satisfaction.
17. Very long-run returns from common stocks are driven by two critical factors: the dividend yield at the time of purchase, and the future growth rate of earnings and dividends. Long-run equity return = Initial dividend yield + growth rate.
18. In principle, common stocks should be an inflation hedge, and stocks are not supposed to suffer with an increase in the inflation rate. In theory at least, if the inflation rate rises by 1 percentage point, all prices should rise by 1 percentage point, including the values of factories, equipment, and inventories.
19. Although I remain convinced that no one can predict short-term movements in securities markets, I do believe that it is possible to estimate the likely range of long-run rates of return that investors can expect from financial assets. Corporate bonds – 4.5%, 10-year Treasuries – 3%, S&P 500 – <7%.
Investment Principles and Guidance
1. Investors would be far better off buying and holding an index fund than attempting to buy and sell individual securities or actively managed mutual funds.
2. Avoid get-rich-quick schemes. It is not hard to make money in the market. What is hard to avoid is the alluring temptation to throw your money away on short, get-rich-quick speculative binges.
3. Look at a company’s/industry’s ability to make and sustain profits. The key to investing is not how much an industry will affect society or even how much it will grow, but rather its ability to make and sustain profits.
4. To estimate the proper value of a stock, you could use the 4 determinants a fundamentalist does: 1) The expected growth rate. 2) The expected dividend payout. 3) The degree of risk. 4) The level of market interest rates.
5. Rule 1: A rational investor should be willing to pay a higher price for a share the larger the growth rate of dividends and earnings. Rule 2: A rational investor should pay a higher price for a share, other things equal, the larger the proportion of a company’s earnings paid out in cash dividends or used to buy back stock. Rule 3: A rational (and risk-averse) investor should pay a higher price for a share, other things equal, the less risky the company’s stock. Rule 4: A rational investor should pay a higher price for a share, other things equal, the lower the interest rates.
6. Many analysts use a combination of techniques to judge whether individual stocks are attractive for purchase. One of the most sensible procedures can easily be summarized by the following three rules. Rule 1: Buy only companies that are expected to have above-average earnings growth for five or more years. Rule 2: Never pay more for a stock than its firm foundation of value. Rule 3: Look for stocks whose stories of anticipated growth are of the kind on which investors can build castles in the air.
7. Look for growth situations with low price-earnings multiples. Beware of very high multiple stocks in which future growth is already discounted. If growth doesn’t materialize, losses are doubly heavy—both the earnings and the multiples drop.
8. The golden number of stocks to hold is at least fifty equal-sized and well-diversified U.S. stocks. With such a portfolio, the total risk is reduced by over 60 percent. Further increases in the number of holdings do not produce much additional risk reduction.
9. Any investment that has become a topic of widespread conversation is likely to be hazardous to your wealth. Invariably, the hottest stocks or funds in one period are the worst performers in the next.
10. Avoid overtrading: Investors accomplish nothing from this behavior except to incur transactions costs and to pay more in taxes.
11. If You Do Trade: Sell Losers, Not Winners: Moreover, investors are likely to avoid selling stocks or mutual funds that went down, in order to avoid the realization of a loss and the necessity of admitting that they made a mistake.
12. The harsh truth is that the most important driver in the growth of your assets is how much you save, and saving requires discipline. The single most important thing you can do to achieve financial security is to begin a regular savings program and to start it as early as possible.
13. Don’t be caught empty-handed: cover yourself with cash reserves and insurance. For individuals, home and auto insurance are a must. So is health and disability insurance. Life insurance to protect one’s family from the death of the breadwinner(s) is also a necessity. You don’t need life insurance if you are single with no dependents.
14. Remember the overarching rule for achieving financial security: keep it simple. Avoid any complex financial products as well as the hungry agents who try to sell them to you.
15. Money-market mutual funds often provide investors the best instrument for parking their cash reserves.
16. Learn how to dodge the tax collector (legally of course). But I do mean to suggest that you take advantage of every opportunity to make your savings tax-deductible and to let your savings and investments grow tax-free.
17. You must decide at the outset what degree of risk you are willing to assume and what kinds of investments are most suitable to your tax bracket. Finding your sleeping point is one of the most important investment steps you must take.
18. Don’t let low commission rates seduce you into becoming one of the legion of unsuccessful former day traders. There is much about investing you cannot control. But you can control your investment costs. And you can organize your investments to minimize taxes.
19. Therefore, within each investment category you should hold a variety of individual issues, and although common stocks should be a major part of your portfolio, they should not be the sole investment instrument.
20. The most important investment decision you will probably ever make concerns the balancing of asset categories (stocks, bonds, real estate, money-market securities, and so on) at different stages of your life. more than 90 percent of an investor’s total return is determined by the asset categories that are selected and their overall proportional representation.
21. A substantial amount (but not all) of the risk of common-stock investment can be eliminated by adopting a program of long-term ownership and sticking to it through thick and thin (the buy-and-hold strategy discussed in earlier chapters).
22. The longer the time period over which you can hold on to your investments, the greater should be the share of common stocks in your portfolio.
23. For those in their twenties, a very aggressive investment portfolio is recommended. At this age, there is lots of time to ride out the peaks and valleys of investment cycles, and you have a lifetime of earnings from employment ahead of you.
24. The do-it-yourself step: Potentially useful stock-picking rules. Rule 1: Confine stock purchases to companies that appear able to sustain above-average earnings growth for at least five years. Rule 2: Never pay more for a stock than can reasonably be justified by a firm foundation of value. Rule 3: It helps to buy stocks with the kinds of stories of anticipated growth on which investors can build castles in the air. Rule 4: Trade as little as possible.
25. The two variables that do the best job in predicting future performance of money managers are expense ratios and turnover.
26. The problem with investment advisers is that they tend to be quite expensive and are often conflicted. Many investment advisers will charge you 1 percent of your assets per year or more for the service of establishing an account with an appropriately diversified portfolio. In addition, some advisers may be conflicted and will use investment instruments on which they earn an additional commission. If you feel you must get an investment adviser, make sure that adviser is a “fee only” adviser.
What I Liked
- Perfect depth of coverage without getting into the weeds
- The book has been re-released many times, with updates each time
Benefits To Your Life and Career
- Get an encompassing view of the finance/investing world
- You’ll realize you only need a handful of principles for saving and investing
- Avoid common pitfalls and position yourself well financially